DEAL OF THE YEAR: Financing Innovation

Jan 1, 2013

Banco do Brasil $1bn Hybrid Tier I Perpetual Bond

Just how Basel III will affect banks’ capital
requirements in Brazil is still far from clear. So when Banco
do Brasil introduced a new type of hybrid security in January
2012 that would be Basel III compliant — irrespective
of what that might ultimately mean — it was thinking
well ahead of its competitors.

The $1 billion hybrid tier 1 perpetual NC11 bond was the
third ever Basel III-compliant bond – as well as a
first in emerging markets – and has set a template for
other financial institutions as they prepare to adapt to a new
regulatory environment.

"This is a landmark transaction that has changed the
landscape of investments available," says Marcelo Delmar, head
of LatAm DCM at BNP Paribas, a bookrunner on the deal with
Banco do Brasil, Citi, HSBC and Standard Chartered.

The structure was a result of the financial crisis, and is
meant to help financial institutions as going concerns.
Previous tier 1 perpetuals would aid borrowers during
liquidation events, but were not useful for healthy banks that
were going concerns (as they couldn’t write off
principal as long as they are a going concern).

"We dind't have an indication of how Basel III would be
implimented in Brazil, but at the same time we know that Brazil
is participating in the dicussions with the Basel committee,"
says Daniel Maria, executive director at Banco do
Brasil. "We established a number of protections for the
investors, and that was the key for the transaction."

The structure allows Banco do Brasil to qualify the issue as
tier 1 capital under current and future regulations.

In a key innovation, the documentation includes a
'qualifying amendment’ or 'floating
indenture’ that allows the borrower to amend
conditions unilaterally once new Basel III regulations are
implemented in Brazil.

"These types of provisions set a new standard relative to
the other post-Basel III deals," says Chris Gilfond, co-head of
LatAm debt at Citi. He says it is the first transaction with
principal writedown provisions. If the bank needs capital these
debt investors get written down, without a provision to get
written back up. The bond was perceived as junior to the
equity, with lenders taking losses before the equity is even
diluted.

The BB rated bond generated a book of $6.2 billion before
pricing at par to yield 9.25%, higher than the bank usually
pays but below its normal 13%-14% cost of capital.

The unsecured and subordinated structure carries no step-up
and offers different interest and loss absorption trigger
mechanics than Banco do Brasil’s previous
perpetual bonds. However, buyers were drawn to the perceived
value of getting the over 9% yield for exposure to the
government-owned bank that would almost certainly count on a
bailout from Brasília if it got into trouble.

"Investors demonstrated confidence with the structure and
particularly with Banco do Brasil risk," says Rodrigo
González, head of LatAm DCM at Standard Chartered.
European and the Middle Eastern investors represented 41% of
the distribution, Asian buyers 27%, North Americans 24% and
LatAm 8%. Private banking was the top investor class, taking
49%, fund managers followed with 37%, and banks and financial
institutions 14%.

With the bonds trading up above 109, Banco do Brasil
followed a month later with a $750 million retap. The bank
reopened at 108.50 for a 8.488% yield. The return was more
evenly distributed than the original with about one-third
participation coming from each of the Americas, Europe and
Asia. Bankers are confident others can follow.

"This is non-dilutive tax-deductible equity," says Delmar.
"Why would you raise equity if you could do this? This is not
only an option for banks. Corporates will think long and hard
before raising equity." LF

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